Ben Graham’s Book Review: “The Intelligent Investor”

Ben Graham’s Stock selection for the defensive investor. Graham lays out some important characteristics of “value” stocks. (p. 348). Some of the metrics are dated, but the principles are still valid. Even deep value investing today would seem like GARP investing to Ben Graham. Investors are now more focused on future earnings than they were in his day, and valuations reflect that. Graham recommends:

a. Adequate size of the enterprise (>$100M revenue, old figure)

b. Sufficiently strong financial condition (2:1 current ratio)

c. Earnings stability (some earnings every year last 10 years)d. Dividend record (uninterrupted payments for at least 20 years)

e. Earnings growth (1/3 increase in per share EPS past 10 years)

f. Moderate price/earnings ratio (P/E < 15x average last 3 years EPS)

g. Moderate ratio of price to assets (price/book < 1 1/2 times)

h. Overall stock portfolio, when acquired, should have an overall earnings /price ratio- the reverse of the P/E ratio – at least as high as the current high-grade bond rate. A P/E no higher than 13.3 against an AA bond yield of 7.5%

Margin of Safety as the central concept of value investing.

“A fourth business rule is more positive:

“Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it- even though others may hesitate or differ. You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right. Similarly, in the world of securities, courage becomes the supreme virtue after adequate knowledge and a tested judgment are at hand. “

This is an investment rule that was written by a man who had been deeply bruised by bear markets. I believe he came up with this by learning from his losses. When the market turns into a storm of feces, like it inevitably will, if the stock has no earnings to rely on, you have nothing to grab onto. You can’t make yourself stay in the stock when the price is down. Graham says: (p. 515) “The margin of safety is the difference between the percentage rate of the earnings on the stock at the price you pay for it and the rate of interest on bonds, and that is to absorb unsatisfactory developments”. Furthermore he writes: (p. 518) “The buyer of bargain issues places particular emphasis on the ability of the investment to withstand adverse developments. ” You can and will still lose money in the market with value-oriented investing, but according to Graham: (p. 518) “The margin guarantees only that he has a better chance of profit than for loss-not that loss is impossible.” Conclusion

“Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it- even though others may hesitate or differ. You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right. Similarly, in the world of securities, courage becomes the supreme virtue after adequate knowledge and a tested judgment are at hand. “